Gold is Not Falling… The US Dollar is Rising

Gold fell below $770 US in trading today as the US dollar index surged above 83. As a Canadian investor, the drop in the gold price today was not very significant measured in Canadian dollars. Gold is still well above $900 in Canadian dollars, and the fall to around $770 US, only pushed gold down slightly to around $930 Canadian. As long as gold falls only when the dollar rises, foreign investors should experience very little fluctuation in the price movement. Until gold falls below $900 and $850 in Canadian dollars, I do not think that it is fair to claim that the value of gold is actually falling.

It is far more accurate to look at the price of gold, not as fundamental weakness in the metal, but as artificial and temporary strength in the dollar. At some point, the dollar will turn around and start to fall against all the major foreign currencies and the decline could be faster than the assent. The rise in the value of the dollar can only be explained through deleveraging, a misguided flight to “quality”, or the last remaining bubble yet to burst. With ridiculously low yields on treasury bonds, and Helicopter Ben making frequent money drops, the dollar in the long run will likely be one of the worst positions to hold. The current strength in the dollar can disappear as quickly as the dot-com stocks of the late 1990’s, or the inflated housing prices that existed throughout most of the United States. Even though the rise in the dot-com stocks and housing prices were equally as irrational as the current rise in the dollar, the increases happened none the less. Rational investors who looked at the insane price valuations of these assets were shocked at how high these prices went, when the fundamentals kept getting worse. The same can be said for the current rise in the dollar. I am surprised by the current strength in the dollar, in the same way that many were surprised at the high prices of dot-com stocks and houses.

It is important to recognize that the rise in the dollar is temporary. How high the dollar could go in anyone’s guess. Earlier this year, I would have never dreamed the US dollar would ever get back up this high to begin with. I think if people really understood what was occurring, no one would want to hold dollars. But the vast majority of investors have no clue what is happening to the economy and are buying up dollars, just as many were buying up dot-com stocks and mortgage backed securities at one time. Anyone who followed the herd in the past got burned when the bubble finally popped, so investors must resist the temptation to jump on board with the rising dollar. At some point, the dollar bubble will burst. I predict that the US dollar index will break below 70 sometime in 2009, which will be followed by a very steep decline, as the dollar enters new territory on the dollar index, without any support below.

In the mean time, investors holding US dollars should be thrilled at the artificial and temporary purchasing power their greenback provides. This phony rise in the US dollar is allowing holders of US dollars to purchases assets, such as gold, at a big discount. It is impossible to call the top in the dollar, and therefore impossible to call the bottom in gold, but I would encourage any investors who are still holding onto dollars to start looking at the types of assets they would like to buy. When the dollar turns around to head lower, the decline could be swift, so investors will have to be ready to dump their dollars at the first sign of trouble in order to get out ahead of the masses. Holding onto dollars is very dangerous, since dollars can be dumped in overseas markets. Investors do not want to wake up one morning to find out that the dollar lost its phony purchasing power while they were sleeping.

When the dollar bubble bursts, the dollar index will fall and gold will rise. Investors who manage to buy cheap gold with their expensive US dollars before this turning point will experience incredible profits while the majority of Americans discover that their money no longer buys anything.